Your 401(k) can pay for a down payment and closing costs on FHA or Conventional. You can borrow from the plan and pay yourself back through payroll, or withdraw the money for good. Lenders accept either one with paperwork, and on the same $12,000 the loan usually costs thousands less in tax.
Borrowing from your 401(k)
IRS rules let a plan lend you the lesser of $50,000 or half your vested balance. A plan can also allow up to $10,000 even when half your balance is smaller. Vested means the money that's fully yours, including the employer match once you've worked long enough to keep it. With a $40,000 vested balance, the most you can borrow is $20,000.
You repay the loan in equal payments that include principal and interest, at least every quarter, and most plans take it straight out of your paycheck. The standard term is five years, and a loan used to buy your principal residence can run longer when your plan allows it. The interest goes back into your own account. If you stop paying, the unpaid balance is treated as a taxable distribution.
Fannie Mae lists borrowed funds secured by a 401(k) as an acceptable source for the down payment, closing costs and reserves. The lender documents the loan terms and the transfer of the money to you. Fannie Mae also says the monthly payment on a loan secured by your own financial assets doesn't have to be counted as long-term debt, so a payroll deduction for your 401(k) loan doesn't shrink your Conventional approval.
FHA accepts retirement money too. The lender documents the account, subtracts any loan already against it, and wants proof the money actually came out of the plan when it's going toward closing. When the same account also counts as your reserves (money left in the bank after closing), Fannie Mae has the lender reduce its value by the amount you borrowed.
Taking a withdrawal instead
The IRS lets a 401(k) plan treat costs directly tied to buying your principal residence as a hardship, so many plans allow a hardship withdrawal for a home purchase. The withdrawal is taxed as income, except any Roth contributions, and it may carry the 10% additional tax on early distributions if you're under 59 1/2. It can't be paid back into the plan.
People often hear about a $10,000 first-time homebuyer exception to that 10%. It belongs to IRAs, and a 401(k) withdrawal doesn't get it. Florida has no state income tax, so the cost is federal only.
A worked example: $12,000 two ways
Jamie is 38, has $40,000 vested in a 401(k), and needs $12,000 for closing costs on a Conventional purchase. Jamie is in the 22% federal tax bracket.
| 401(k) loan | Hardship withdrawal | |
|---|---|---|
| Amount taken from the account | $12,000.00 | $17,647.06 |
| Federal income tax (22%) | $0.00 | $3,882.35 |
| 10% additional tax | $0.00 | $1,764.71 |
| Cash in hand | $12,000.00 | $12,000.00 |
| Monthly cost | $243.32 for 60 months | $0.00 |
| Money that goes back to the account | All $14,599.20 of payments | None |
The loan math assumes the plan charges 8% for five years. Each $243.32 payment goes back into Jamie's account, including the $2,599.20 of interest. Fannie Mae doesn't require the $243.32 to be counted in Jamie's debt-to-income ratio.
To net $12,000 from a withdrawal, Jamie has to take $17,647.06, because 32% of it, or $5,647.06, goes to federal tax: $3,882.35 of income tax plus the $1,764.71 additional tax.
Other ways to cover the cash
Plenty of Florida buyers close without touching retirement money at all. FHA 100% financing pairs a 96.5% FHA first mortgage with a down payment assistance second that covers the 3.5%, so the down payment comes from the program. The seller can pay up to 6% of the price toward closing costs on FHA, and family can gift money with a signed gift letter. Florida Housing's assistance programs, including Hometown Heroes, help eligible buyers with both the down payment and closing costs.
A 401(k) loan can also work alongside those. A buyer using FHA 100% financing with a 3% seller credit sometimes needs only a few thousand dollars, and a small plan loan covers it.
Before you call your plan administrator, run your price through the cash to close calculator to see how much cash the purchase needs. Then call AAA Capital Funding at 888-601-8344. We'll tell you whether the 401(k) is needed at all, and if it is, exactly which statements the lender will ask for.